Export Price Competitiveness and

Exchange Rate Risk in Pakistans

Manufacturing Sector
Uzma Zia

Pakistan Institute of Development Economics



Introduction
The globalization of markets involves intensification of
international competition that is forcing countries to be
competitive in export markets.

Competitiveness concerns stand high on the agenda of
national governments and the concept of competitiveness
has attracted a lot of attention.

Improved competitiveness of economies in general and
firms and their products in particular is a need of the day.

The ability of products/firms to compete in the world
market is a major concern for policy makers.
Contd
Competitiveness assessments are important in
evaluating a countrys macro economic performance
and for evaluating sustainability of its policies.

Various measures to estimate competitiveness
Trade Related (RCA,CMS)
Productivity Related (TFP)
Efficiency Related (Stochastic Production
Functions)
Price Related (Relative Trade Prices, Unit Labour
Cost, Real Effective Exchange Rate)
Objectives

Main aim is to study export-price competitiveness of
Pakistans manufacturing sector and motivation
comes from my earlier work by cointegration
analysis on this issue.

More specific objectives are:

To analyze Pakistans trade pattern and factors
affecting export-price competitiveness.

To see effects of exchange rate volatility/risk on
export-price.






Assessment of Export-Price
Competitiveness

Export-Price Competitiveness is mainly assessed by
the following :
Import prices
Unit labour cost
Exchange rate



Exchange Rate Volatility/Risk
Exchange rate volatility play an important role in
export performance.

Increased volatility in exchange rate is assumed
to result in increased uncertainty about future
profitability of a firm/exporter.

The volatility has an impact on decisions of the
firms that are engaged in trade, if the firms are
risk averse.

Standard theory assumes that exchange rate risk
depresses international trade.


Review of Studies available internationally and for Pakistan on measuring Competitiveness

Author
Country Study Period Method/Technique Remark
Mehmood (2004) Pakistan 1990-2000 Trade related measure:
-Revealed comparative
advantage (RCA) approach.
-Analyzed comparative advantage
and disadvantage of Pakistans non
agriculture production sectors
Ara (2004) Pakistan 1972-73 to 2002-03 Trade related measure:
-Revealed comparative
advantage (RCA) approach.
-Assessed cost competitiveness of
manufacturing sector of Pakistan
Hanif and Jafri
(2006)
Pakistan 1974-2004 Trade related measure:
-Balassa Index
-Explored relationship of financial
sector development and
international trade competitiveness
in Pakistan
Chowdhury, (2005) Bangladesh,
India, Pakistan
and Srilanka
1960-2000 Price related measure:
-Construction of real exchange
rate indices.
-Measured intra-regional and
international trade competitiveness
for four SAARC nations
Brunner and Cali
(2006)
South Asian and
OECD countries
1991-2002 Price related measure /Unit value
method:
-Comparative analysis
-Analyzed export competitiveness
and export quality of South Asian
countries manufacturing relative to
OECD countries
Abeysinghe and
Yeok (1998)
Singapore 1980-1993 Price related measure:
-Price Competitiveness
method
-Empirically shows export
competitiveness in Singapore
Harding (2001) Australia 1970-2000 Price related measure:
-Price Competitiveness
method and
Real Trade Weighted
Index of Exchange rate
-Assessed Australias price
competitiveness and structural change
Fang and Miller
(2007)
Singapore 1979-2002 Price related measure:
-Price Competitiveness
method
-Finds relationship between exchange
rate depreciation and exports in
Singapore
Lakshmanan (2007) India 1980-81 to 2003-04 Price related measure:
-Price Competitiveness
method
-Provides analytical analysis of
parameters of manufacturing
competitiveness in India
Chowdhury (1993) G-7 countries 1973-1990 Price related measure:
-Price Competitiveness
method
-Examines exchange rate volatility on
trade flows of G-7 countries.
Methodology
The empirical analysis is performed in two parts:
Assessment of exchange rate changes on
export-price competitiveness of Pakistans
manufacturing sector.
Exchange rate risk analysis for export
competitiveness.
Empirical methodology followed in this
research is adapted from Abeysinghe and Yeok
(1998) with certain modifications.

Model I Export Price Competitiveness


P
x,t
Export price index in year t.
P
m,t
Import price index in year t.
SBRT
x,t
Export subsidies in year t.
UBC
t
Unit business cost in year t.

) 1 ( ln ln ln ln
, , 3 2 , 1 0 ,
+ + + + =
t x
t
x t t m t X
P SBRT UBC P P o o o o
Modifications
Abeysinghe and Yeok has taken UBC as composite
index of unit labour cost, services cost, and
governmental rates and fees. In this research UBC is
(based on employment cost and cost of electricity
and fuel--Index is made by dividing these costs by
value added in the manufacturing sector).
There are no export subsidies in Abeysinghe model
but in case of Pakistan subsidies are important
determinants of exports. Export subsidies that reflect
the extent to which price paid by foreign importers
of the exportable is reduced (captures the impact of
export promotion policies.)

Model-II: GARCH-M
To investigate volatility in exchange rate, the
GARCH(1,2)-M based on SC criteria model is
used to capture the effects of the exchange rate
through import prices on export-price
competitiveness.

An important application of ARCH and
GARCH models is to measure and forecast the
time varying volatility.


t t t
t
x t m o t x
U f UBC
SBRT P P
+ + +
+ + =
) (
2
4 3
, 21 , 1 ,
o | |
| | |
GARCH-M: Mean and Variance
Equation
Mean Equation:
This equation shows the relationship between export-price,
import-price, export subsidies and unit business cost. In
addition, the coefficient 4 measures the trade-off between
exchange rate risk and export competitiveness, in other
words it explains the needed compensation to exporter for
facing exchange rate risk.

Contd
2 2
1
2
i t i t O t
+ + = |o o o o
Variance Equation:
This equation captures the effect of volatility in export
competitiveness due to exchange rate risk captured by
import-price.
Data
Variables needed for this research are:
Export price index (Px)
Import price index (Pm)
Export Subsidies (SBRTx)
Unit business cost (UBC)

Annual data used are from 1970-2008.

All time series data are tested for
stationarity using ADF test.
Data Sources
Censes of Manufacturing Industries
(CMI)
Statistical Year Book of Federal
Bureau of Statistics (FBS)
International Financial Statistics
(IMF)
CBR Year Book
Economic Survey (various issues)

Estimation Procedure
1- Augmented Dickey Fuller (ADF)non stationary-Log
first difference.

2- Relationship by estimating multivariate regression
model by Ordinary Least Square (OLS).

3- Exchange rate risk analysis by applying Generalized
Autoregressive Conditional Hetroscedasticity
(GARCH).
Stationarity
The ADF test indicates the acceptance of
the unit root hypothesis at level, that is, the
time series have a unit root.
The results indicate the first differences of
variables of export price, import price,
export subsidies rate and UBC are on a
stationary process, as the null hypothesis of
unit root is rejected. Hence, these series are
integrated of order 1, i.e., d(1).
Relationship between export-price
competitiveness and its determinants
Note: * indicates statistical significance at 1% level. ** indicates statistical significance at 5% level.
Variable Coefficient t-stat
Import Price (P
m
) 0.71* 5.89
Export Subsidies (SBRT
x
) 0.03 1.36
Unit Business Cost (UBC) -0.49* -2.17
Export Price (-1) 0.22** 1.71
Constant 2.15 2.09
0.98
Durbin-Watson statistic 1.74
F-statistic 676.45
Adjusted R
2

Relationship by OLS
Relationship - estimated by regressing export-price on
import-price, export subsidies and UBC.
OLS technique is used.
Results show:
Import prices - positively and significantly associated
with export price competitiveness.
Subsidies - positively but insignificantly associated with
export competitiveness.
Unit business cost negatively and significantly affecting
the export competitiveness.
Lag of exports- positively and significantly affecting
export competitiveness.
Analysis shows significance of import-price (also
reflecting changes in exchange rate) and UBC on export-
price competitiveness.
Contd
The relationship between export-price and import-price
is positive because the lower import content in the
production of exportables allows exchange rate
depreciation to significantly impact the export-price
competitiveness. (Overall devaluation of Pak currency
viz a viz US dollar is 7.61 percent in 1972-2008).

In addition to exchange rate changes, productivity
gains also contribute to enhance export
competitiveness. (Overall average of TFP growth rate
is 1.81 percent in 1972-2008).

Thus positive changes in domestic value added in the
presence of currency adjustment play an important
role in improving export-price competitiveness.

Export-price competitiveness with GARCH (1, 2)-M
Coefficient Z-statistic
Mean Equation:
GARCH-M

0.108***

2.073
C 1.480*** 1.884
P
m
0.522** 9.366
SBRT
x
0.071** 3.894
UBC -0.365** -2.182
Export(-1) 0.374** 7.205
Variance Equation:
C 0.0014*** 0.619
ARCH(1) 0.804 1.486
GARCH(1) -0.298*** -1.708
GARCH(2) 0.385*** 1.695
Adjusted R-squared 0.98
Note: ** indicates statistical significance at 5%. *** indicates statistical significance at 10%.
GARCH-M
Import Price Index calculated on the basis of domestic currency
captures variability in exchange rate.
GARCH-M term is positive and significant indicating that
exchange rate risk has positive and significant compensation of
risk on export competitiveness.
Variance equation explains how much variance is affected by the
past lag residuals and how much is influenced by past variance.

GARCH (1) significant
GARCH (2) significant

The significance of GARCH terms shows previous variance is
significantly contributing to current variance.
Exchange Rate depreciation risk decreases export-price
competitiveness.
Conclusion
Conclusions are:

Exporters react differently to the exchange rate and its
associated risk. Findings reveal that exchange rate risk has
positive and significant compensation, affecting export
competitiveness.

In case of Pakistan we find that the exchange rate risk also
influence export price and the domination of exchange rate
risk leads to a decrease in export competitiveness resulting
into weak export growth.

Policy Recommendations
The analysis of this study leads us to several policy implications:
Policymakers need to carefully watch movements in import prices
denominated in local currency, and export subsidies. There is a
need to create a synergy between trade policy and exchange rate
policy. Reduction in exchange rate fluctuations and reducing anti-
export bias will be desirable policy instruments.

Policy makers may consider prudent foreign exchange market
interventions since exchange rate risk factor do offset positive
effects of depreciation.

The government may take measures to enable exporting firms in
upgrading and meeting international standards by streamlining
technology development. This would enable industries to achieve
high growth in total factor productivity.








Thank You